Tax Tips for New Small Business Owners
Start-Ups, Entrepreneurs and Beginners
A small business owner needs to know about taxes. A common challenge for most start-up small businesses is learning the IRS tax requirements and regulations. You may want to start your own small business, or you may be a small business owner who wants to see the business grow and profit.
Is Your New Small Business a Business or a Hobby?
The taxes you pay on your new small business depend on whether the IRS classifies it as a business or a hobby. For tax purposes, it’s important that your enterprise be classified as a business. If it’s a business, you can deduct your losses from other personal income, such as salary, interest income or investment income. In addition, you can carry over the unused business loss to offset future year’s profits.
If you have a hobby, you can only deduct your hobby expenses from your hobby income. You can’t deduct your hobby loss from your personal income. And you can’t carry over the hobby loss to offset hobby profit in future years.
The IRS has lots of rules to determine if your new small business is a business or a hobby. Is your motive to earn a profit, and do you continuously and regularly engage in the business over time? If you’ve earned a profit in the last three out of five years, you’ve got a business. But many startup businesses don’t turn a profit for many years. So, if you keep good records, demonstrate expertise in the field, and work regularly, it’s likely your business will be recognized. Even a man who gambled on the dog races full time could show the IRS that he was in a business. But a millionaire who said he traveled the world collecting material for his first book, “My 27-Year Search for the Perfect Steak”, but had no publisher lined up, was ruled to have a hobby, rather than a business. You chance of being audited is about 1%, unless your business looks like a blatant tax scam.
Organize Your New Small Business for Income Tax Benefits
How your new small business is organized determines what taxes you must pay and how you pay them. A small business is either a sole proprietorship, a partnership, a Limited Liability Corporation, LLC, an S-Corporation, or a C-Corporation.
- Most small businesses are sole proprietorships, with a single owner. You’ll report your net business profit or loss on Form 1040, with Schedule C attached to show your business income and expenses.
- If your business has two or more owners, it is a partnership. The business will file a partnership information return each year, Form 1065 with Schedule K1 attached to show each partner’s share of the profit or loss. However, the partnership does not pay the income tax. Each partner reports the profit from Schedule K1 as income on his/her personal Form 1040 tax return.
- A Limited Liability Corporation, LLC, is a corporation with limited liability to protect the owners, but for tax purposes it passes its income through so that the owners can report the corporate income with their personal income.
- A C corporation files its own tax return on Form 1120 and pays its own taxes on its corporate income. The owners of a C-Corporation pay personal income tax only on the salary or dividends they receive from the business.
A New Small Business Pays Employment and Sales Taxes
If your new small business is organized as a sole proprietorship or a partnership, you will pay self-employment taxes on the profits. No matter how your business is organized, if you have employees, your business tax expense includes employment taxes. The business pays half of the employees Social Security tax, half of the employees’ Medicare tax, as well as Workers’ Compensation Tax, Federal and State Unemployment Compensation. These employment taxes are all computed as a percent of the wages the business pays its employees.
Whenever your business sells a product or service, it must collect the state sales tax from the customer. The sales tax is remitted directly to the state on monthly tax returns. Your business does not pay state sales taxes on goods and services it purchases for resale or to manufacture goods for resale. However, the business pays sales tax on its other purchases. And when the business purchases items out of state, from vendors who are not paying the state sales tax, the business must pay a use tax on the purchases.
A New Small Business Pays Estimated Federal Income Tax
You know that, when you were an employee, your income taxes were withheld from your wages every pay period. Now, as a businessperson, you will pay estimated taxes on the profits your business is earning during the year. If you own a corporation, it will also pay estimated income taxes. Estimated federal income taxes are paid quarterly, and reduce the amount of income tax you pay at the end of the year.
Your new small business might not have to pay estimated income taxes. The easy way to estimate your income tax for the current year is to start with same tax you paid in the prior year. Each quarter of the year, you pay ¼ of your estimated federal income tax. There’s no estimated income tax due if you paid no tax last year or if you expect to have less than $1,000 tax liability this year. Of course, you are still must file and pay income taxes at the end of the current year.
A New Small Business Pays State and Local Taxes
In addition to federal taxes, your business will also pay state income or franchise tax, and income tax in the cities where it has a business presence. Businesses also pay a state or county intangibles tax on the inventory and other property used in the business. If it owns real estate, the small business also pays real estate property tax. In some areas, the small business may have to pay a local school district tax. Specific business activities are also taxed. For example, there is a highway mileage tax if your business operates heavy-duty over-the-road trucks. Because of the variety of taxes, it is important that the owner of a new small business has a reliable bookkeeper or accountant to handle the tax reporting responsibility.
A New Small Business Keeps Records for Taxes
What records should your new small business keep? The business should keep a record of each sales invoice and each purchase. Cancelled checks, bank statements, and credit card statements will help make recordkeeping easier. Once your business is established, computer bookkeeping software like Peachtree or Quicken will make recordkeeping easier.
Be especially careful about business travel, meals and entertainment, vehicles, gifts. For all meals and entertainment expenses, keep a record of the business purpose and the people attending. Your records of travel expenses should show the business purpose of the trip. If you use your car for both business and personal trips, your records should show each business trip taken, with the destination and the mileage. It is recommended that you keep your tax returns indefinitely, and that you keep all supporting documents six years after you file your tax returns.
I hope life brings you much success. I wish you a very happy day.
----- Surfer Sam